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Interest Paid as an Administrative Expense

A
court held that interest an estate pays on a charitable bequest is
deductible as an administrative expense for estate tax purposes. Betsy
Carolyn Turner was executor of the estate of Sally C. Jackson, who died
in 1997. Jackson’s will made a bequest of $10 million to Fowler Homes on
the condition it be recognized as an IRC section 2055(a) charitable
organization. Fowler claimed tax-exempt status by virtue of its
affiliation with the Disciples of Christ church. Turner waited until the
estate received a closing letter for the IRS before funding the bequest.

Under Texas law interest began accruing at a 6% annual rate one year
from the date the state issued testamentary letters to Turner. She
funded the bequest on October 19, 1999, in the amount of $11,052,055,
including interest. On September 13, 2000, Turner filed a refund claim
seeking $450,108 based on an estate tax deduction of $1,052,055 in
statutory interest. The IRS rejected the claim, arguing the estate
should deduct the interest on its income tax return.

Note: The deduction was worth more on the estate tax return than on
the income tax return since, in 2000, the top estate tax rate was 55%
while the top individual tax rate was only 39.6%.

Result. For the taxpayer. For an
administrative expense to be deductible under IRC section 2053, it
must be (a) incurred in the administration of the decedent’s estate,
(b) actually and necessarily incurred and (c) allowable by the laws of
the jurisdiction under which the estate is being administered. The IRS
challenged Turner’s assertion that the estate had met the second
criteria. The IRS argued Turner had enough information (for example,
church publications) from Fowler Homes to fund the bequest at an
earlier point in time, and therefore, the interest paid was not
“actually and necessarily incurred.”

The court disagreed, stating that given the size of the bequest and
the explicit requirement in the decedent’s will that Fowler Homes be a
charitable organization, Turner had “prudently determined” that the
available information “was not reliable enough to permit funding of
the bequest.”

This case illustrates that as long as an estate takes reasonable
steps to fulfill and document a decedent’s instructions, IRS
challenges should prove unsuccessful.